Business at Oxford | Indian retail can be world’s best

The recent announcement of UK retailer Tesco Plc.’s alliance with Trent Ltd, the retail arm of the Tata group, follows on from a similar agreement between Wal-Mart Stores Inc. and Bharti Enterprises, to supply goods and provide world-class retailing expertise. Such agreements are seen as the obvious response for international multi-brand retailers to the current constraints on foreign direct investment, or FDI, in India.

While many people will argue that the FDI constraints will not defend small shopkeepers from the inevitable power derived from the economies of scale offered by the hypermarket business model, there are many lessons to be learnt from these foreign retailers in their well-developed domestic markets that could provide a better way forward for Indian retailing, with major implications not only for small retailers and foreign competitors, but also for Indian society and the global environment.

In order to consider the future of Indian retailing, let us review the development of retailing and distribution in Tesco’s home market.

In broad terms, there are two distribution models operating in the UK grocery market: a large retailer model (Tesco, Wal-Mart’s Asda chain, J. Sainsbury Plc., William Morrisons Supermarkets Plc. and other multiples) and an independent retailer model (small shopkeepers).

Illustration: Jayachandran / Mint

The supply-chain network for a large retailer is controlled (though not necessarily owned) by the large retailer, often starting from the manufacturer’s factory gate, through regional distribution centres, and into the stores. This supply chain is largely driven by consumer demand at stores through an integrated IT and management system that ensures an efficient, disciplined and standardized operation. Through competition between retailers, as well as the utilization of third-party logistics providers, continual improvement and innovation is sought and regularly achieved — hence, the world-class nature of these distribution models.

The supply chain for an independent retailer is less integrated, with wholesalers playing a key role in receiving products from manufacturers and then selling (and delivering) them to stores. The wholesaler provides economies of scale for the smaller retailer and helps to integrate suppliers and retailers, but does not control them.

The supply chain for a large retailer is much more efficient and responsive than that of the small shopkeeper due to the larger volumes involved. This provides the major grocery retailers not only with advantages in terms of distribution, but also in terms of influence over manufacturers. While distribution costs account for a relatively small proportion of a retailer’s costs, purchasing costs are extremely significant, accounting for approximately 60-70% of costs.

Until recently in the UK grocery market, large retailers and small shopkeepers were considered to be independent markets by the competition authorities. However, over the last decade, the major players have been moving heavily into the convenience (small store) sector. Their “small store” supply chains have been built on top of their existing “large store” supply chains, giving them a competitive advantage over the existing players. Moreover, in light of the environmental and social concerns associated with food miles (the distance food has travelled from the place of production to reach the consumer), traffic congestion and noise pollution, such a solution makes sense for society and environment as it reduces distances travelled, reduces congestion, increases vehicle utilization and cuts waste.

However, this raises the question of fair competition between large stores and small stores within the UK grocery sector, not just in terms of retailing (as already existed with the hypermarket model), but also in terms of distribution. Independent small retailers are disappearing, with many economic, social and environmental benefits in distribution, but potential costs in terms of retail choice.

Thus, the FDI rules in Indian retailing are ultimately irrelevant for small shopkeepers. These rules impact the level of competition between domestic and international retailers adopting a large retailer business model. The ultimate threat to small, independent retailers is from large retailers with a hypermarket distribution system moving into the small store market — regardless of the nationality of their ownership. Moreover, this threat is unavoidable as the wider economic, social and environmental benefits will eventually outweigh the vested interests of independent, small shopkeepers.

So, is there an alternative way for Indian retailing to develop? By accident rather than design, through FDI constraints, the Indian government is creating a two-tier retail and distribution system, with foreign retailers developing a world-class distribution system that aligns with specific Indian retailers, allowing the Indian retailer to learn about world-class distribution, while the foreign business learns about Indian consumers.

Future development will depend on contractual arrangements and the development of government policy regarding foreign ownership, but the assumption must be that the two parties will either merge or set up their own separate businesses, each with the requisite knowledge for running a highly efficient and effective retail and distribution system.

At the current stage of retail development, the Indian government could take a more radical approach aimed at creating the most competitive retail sector in the world underpinned by the most efficient distribution system in the world. Rather than focusing on keeping international multi-brand retailers away from Indian consumers, the government could focus on keeping the distribution (wholesale) network separate from the retail network. A few large distributors could still retain the purchasing power and distribution efficiency of a Wal-Mart or Tesco, while having to compete for demand from the retail community, both large and small.

This retail model would provide three key advantages over the current “Western” model of modern multi-brand retailing.

First, additional economic, social and environmental benefits can be achieved by serving independent stores through the same distribution systems as national retailers.

Second, competition would focus at a national level in terms of purchasing power, thus allowing India to punch its weight within the international market.

And third, competition would focus at the local level in terms of retailing, thus allowing smart, small, independent retailers to punch above their weight — a vital difference to today’s model of modern multi-branded retailing that has the potential for India to create the best retailing and distribution sector in the world.

Richard Cuthbertson is research director at the Oxford Institute of Retail Management and senior research fellow at Saïd Business School.